The California legislature has passed, and Governor Schwarzenegger has signed, a new law conforming California law to the federal law so that homeowners who lost their home in a foreclosure, or who completed a short sale, deed-in-lieu of foreclosure or loan modification during calendar 2009, or after, will not have to pay taxes on the forgiveness of indebtedness, if specified criteria are met.

When there is a forgiveness of indebtedness as a result of a short sale or foreclosure, the amount forgiven is considered income. The federal government has a provision in the Internal Revenue Code which states that, if certain criteria are met, the taxpayer will not have to pay tax on that income.

California had a law which mirrored that federal law, but it expired at the end of 2008.  This new law will provide that, if certain criteria are met, there will be no taxation for California income tax purposes either for closings, or other taxable event, in calendar 2009 through calendar 2012, when the law again is set to expire.

There are limitations, however, and as always you should contact your tax advisor to see whether this law applies to your situation. This is a general summary of this law and does not constitute tax or legal advice for any particular situation. You must discuss your individual situation with your tax advisor before taking action.